ROBERT SHILLER, A 67-YEAR-OLD Yale University professor best known for his early, accurate prediction that U.S. house prices were a bubble just waiting to burst, has long worked at the intersection of psychology and economics. He recently shared the Nobel in economics for insights into why prices of stocks and houses fluctuate as they do, particularly work showing that markets move too much to be explained by rational investors responding to changing fundamentals.

In an interview with WSJ.Money contributor David Wessel, Yale economist Robert Shiller describes his thoughts on what actually drives markets—and recalls his encounter with Alan Greenspan just before the Fed chairman's "irrational exuberance" speech.

Once lauded as both a "poet and plumber"—or, someone who articulates radical new visions and installs the infrastructure needed to implement them—Shiller also has helped develop new financial products and indexes. He recently met with David Wessel, a contributing correspondent to the Journal and director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. Their edited remarks follow:

Q: One theme that runs through your work is that people tend to make mistakes over and over again. That's quite different than what I learned in college economics—that people are rational. How did you start thinking about people's mistakes?

A: When you went to college, the economics profession had reached an unnatural state. Mathematical models of rational behavior became the rage. It was just an abnormal time. I was reading more widely and wanting to come back to reality.

Q: Was there something you saw in reality that led you to this?

A: Well, bubbles. The story about bubbles was that the markets appear random, but that's only because markets respond to new information and new information is always unpredictable. It seemed to be almost like a mythology to me. The idea that people are so optimizing, so calculating and so ready to update their information, that's true of maybe a tiny fraction of 1 percent of people. It's not going to explain the whole market.

Irrational Exuberance

A look at why the term first became famous, and how it evolved over the years.

1996

DECEMBER 3 | Robert Shiller briefs Alan Greenspan, then the Federal Reserve Board chairman, on why he thinks the stock market is in a bubble.

DECEMBER 5 | In a speech, Greenspan asks, "How do we know when irrational exuberance has unduly escalated asset values?" Markets plunge.

2000

MARCH | Shiller publishes "Irrational Exuberance," a book about stock-market booms and busts, which goes on to become a global bestseller.

2005

MARCH 14 | Shiller's book "Irrational Exuberance" is expanded to cover real estate and is translated into more than a dozen languages, including Hungarian, Turkish and Greek.

MARCH 15 | "Irrational exuberance is the last term I would use to characterize what is going on at the moment," Greenspan says of the stock market on CNBC. "It's still got a ways to go."

2014

MARCH | Nearly 32,000 published instances of the phrase "irrational exuberance" have been recorded since 1996, according to the research database Factiva.

Nobel laureate Robert Shiller talks with WSJ.Money contributor David Wessel about the wisdom of investing in real estate and his provocative proposal to arrest the growth of inequality in the U.S.

Q: Are bubbles always a bad thing, or do they have some good effects?

A: First of all, it's a free world and people can do what they want. I'm not proposing we put the straightjacket on these things. The other thing is that human nature needs stimulation and people have to have some sense of opportunity and excitement. I think profits are an important motivator. In the long run, it's hard to say that bubbles are really bad.

Take the Internet bubble in the 1990s. What that did was generate a lot of start-ups, some of them foolish, some of them failed, but others survived, so is it a bad thing? I find it hard to think what the alternative would be. We could have had a Federal Reserve that tried to lean against that. Ultimately, our policies in economics are somewhat intuitive and our models are not accurate enough to tell us what the right policy is, so I'm thinking we might have been better off if we tamed these bubbles, but there is no way to be sure.

Q: A lot of what you do is at the intersection of psychology and economics, and your wife is a psychologist. Did that have any effect on how you developed your work?

A: I'm sure it did. This is the basic principle of psychology: Nobody can explain their mindset, where it came from. People think of themselves as such original thinkers when, in fact, most of their thoughts have been transmitted to them from other people. And there are certain stories in circulation and they are all in all our minds.

Psychologists have argued there is a narrative basis for much of the human thought process, that the human mind can store facts around narratives, stories with a beginning and an end that have an emotional resonance. You can still memorize numbers, of course, but you need stories. For example, the financial markets generate tons of numbers—dividends, prices, etc.—but they don't mean anything to us. We need either a story or a theory, but stories come first. Most people don't really get around to much in the way of theory.

Q: Do you tell investors that they can pick winners in the stock market, or do you tell them they're not expert enough and that they should go to index funds or other products?

A: I tell people to get an investment adviser; that makes sense to me. The question is often whether it's possible for anyone to pick stocks, and I think it is. It's a competitive game. It's like some people can play in a chess tournament really well, but I'm not recommending you go into a chess tournament if you are not trained in that, or you will lose. So for most people, trying to pick among major investments might be a mistake because it's an overpopulated market. It's hard. You have to be realistic about how savvy you are. But if you are thinking about buying real estate and renting it out, fixing it up and selling it, that's the kind of market that's less populated by experts. And for someone who knows the town, that's doing business, I'm not going to tell someone not to do that.

Q: Do you think of yourself as someone smart enough to pick winners in the stock market?

A: Well, I actually think I'm smart enough to pick winners. I've always believed in value investing. Some stocks just get talked about, and people pay all sorts of attention to them, and everyone wants to invest in them, and they bid the price up and they are no longer a good buy. Other stocks, they are boring. There is no news about them—they are making toilet paper or something like that—and their price gets too low. So as a matter of routine, you buy low-priced stocks and sell high-priced stocks.

Can new kinds of insurance protect us from turmoil in our careers or in the real-estate market? Yale economist and Nobel Prize winner Robert Shiller tells WSJ.Money contributor David Wessel that they can.

Q: What's your personal track record: Are you more up than down?

A: I have never done a personal analysis. I have to do that. But I believe that I've done well in timing the market, although not perfectly.

Q: In the late 1990s, when the stock market was looking a little frothy, you delivered a presentation at the Federal Reserve. Your wife later said you expressed concern that you were the one who planted the idea of "irrational exuberance" in Alan Greenspan's head.

A: What you said is absolutely right. Greenspan said the words "irrational exuberance" in an evening speech in Washington, and the Tokyo market, which was still open at that time, immediately crashed and then it spread over the whole world as the markets opened. That's why "irrational exuberance" is famous. Greenspan didn't coin it, I didn't coin it—it was an old phrase. But he just happened to use that phrase and the market immediately crashed.

Q: Did you really feel responsible?

A: I came home and told my wife, "I might have started a world-wide market crash." I said it sort of joking, but I half believed it. The markets are that crazy. The power isn't in me, it's in Alan Greenspan, but I had his ear. I spoke before the Federal Reserve Board and then I had lunch with him. I was talking, so it's possible. This is a method of thinking about the economy that's very different. It makes the economy sound unstable and affected by individual people.

Q: When you look at housing, do you think that the world has changed in that people don't regard it as a sure-thing investment because of what we went through?

A: You referred to an idea that housing is a great investment. But I think if you go back in history that was not the conventional wisdom. You stop a man on the street in 1875 or 1950 and say, "I'm going to buy a bunch of houses and invest in them. What do you think?" I think the usual response the guy would give is, "Are you sure about that? There's a lot of maintenance. They're going to go out of style." If you can create a business renting them out, maybe it's a great investment. But just betting on their price going up, I don't know. I think that was an idea that took hold particularly during the early years of the 21st century.

Ultimately, people are motivated by human-interest stories about somebody who did something amazing because those stories are more resonant, they create a sense of envy and competitiveness. If I've heard stories about someone who bought condos or houses and flipped them and made a huge amount of money, and I think to myself I could have done that, it generates emotional turmoil that drives you to do it. So I'm thinking that's kind of what was happening in the housing market in the early 2000s and in the stock market in the 1990s.

‘"I told my wife, 'I might have started a world-wide market crash.' I said it joking, but I half believed it."’

Q: You have two houses, one in New Haven and one in Stony Creek, Conn., right?

A: Right. It's on an island. We bought that as not an investment—we just thought it would be fun.

Q: If others want to invest, do you advise them to think about the stock market, and if they want to buy a house, do you tell them to live in it?

A: Anything like that is too simple. I'm not enthusiastic about random people buying houses as investments. I think it's a business. You can buy houses and rent them and make money, but that's something that takes effort and time.

Q: We've seen an extraordinary period where the gap has widened between winners and losers in society. What should we do about that?

A: We should start preparing for a day, maybe 10 or 20 years in the future, when inequality may be much worse. We don't yet know whether it's going to be worse. We should have a contingency plan now. The simple idea I have is raising the taxes on the rich, which sounds like the most politically inexpedient move right now, but the nice thing is that when you talk to people about risks of the distant future, they are more idealistic and more sharing in their attitudes.

Q: So we'd have a tax increase on wealthier people that would go into effect if some measure of inequality reached a certain point?

A: Yes. If billionaires turn into multi-billionaires, we don't let that happen. If you want to make $10 billion and spend it on yourself, we won't let you. We will take a good fraction of it, and you'll still be a billionaire, so what?

The other side of it is I think we should expand the charitable deduction, so if you make $10 billion and you want to give 90 percent of it away, you can give it away with your name on it so it enhances your prestige, but give it away and you should be able to deduct it.

Q: So we would more aggressively redistribute income from the top?

A: From selfish people at the top who don't want to give it away. You could turn into a Bill Gates or an Andrew Carnegie. I think that's OK. Instead of just taxing people—saying, "We're just taking the money, and you'll go to jail if you don't turn it over"—we can find a better way.

Q: Winning the Nobel Prize does guarantee the first line of your obit, but it also gives you a kind of exalted status: What you say must be more true than what other people say. Do you worry about that at all?

A: A little bit. I think that economics is not an exact science. It tends to be politicized. It happens when I'm interviewed in occasions like this, I have a sense that you expect me to come up with answers for every one of your questions. But maybe I should say, "I don't know" more often. At this year's Nobel ceremony, I was impressed that [co-winner] Gene Fama said "I don't know" a lot. He kind of avoids the media, so maybe I could learn a lesson from him.

The fundamental issue with Mr. Shiller's comments is that it shows he is ignorant concerning how wealth is redistributed in the private sector. I am now fairly sure he received an economics degree in error.

In the private sector, any time someone purchases a service or a good, they are redistributing their wealth to direct and indirect value producers who have already redistributed their organizations capital to value producers and so on.

As this system continues it eventually supports the job of the marginal worker. Mr. Shiller would prefer that, by taking away my investment and consumption ability, this marginal worker lose his job and become dependent on the government's largesse as it redistributes my money gained through taking. The difference for the marginal worker is that, in the private sector, they gain their money through the creation of value, but, through the government pipeline, they lose self respect and self worth through welfare.

Whether I buy a mansion, a Bugatti or a diner breakfast, I am redistributing my capital. I am exchanging my dollars for an intangible or tangible item and those dollars make their way through the system to support other private economic choices. The more expensive the item is that I purchase, the faster the redistribution. That redistribution makes its way through the productive part of society and then on to the welfare part of society as it is taxed along the way.

Besides consumption, my billions-not-consumed make its way to banks and investment vehicles and investment markets and that activity supports fractional banking loans, equity on balance sheets and capital investments which creates jobs through risk investments.

Even if I was to take all of my billions in dollars and hide in a cave, the fed would replace whatever I tried to hoard which would neutralize my useless act.

What Mr. Shiller is stating is that he believes that the wealthy private sector should not be able to choose where to consume and invest as they redistribute their funds and that some incompetent interloper in the government is a better sherpa to my earned capital. This is a typical elitist Yalie view. He is a good socialist deep down.

I think this is just another example why the Nobel Prize, especially in the soft sciences, has become Olympic Ice Dancing - an activity that is judged by incompetent appointees who use politics and vague concepts to award points to "approved" competitors.

Mr. Shiller is becoming a Krugman.

GG

PS, He was born in Detroit, works for Yale and is a Keynesian. I think this should explain things.

PPS, can someone point to where the government has done an efficient and effective job redistributing wealth?

A contributing factor to the internet bubble of 1999-2000 was the inaction of SEC Chairman Arthur Levitt, and NYSE Chair Dick Grasso -- all the major firms, and I mean ALL put forth preposterous statements in their research -- clearly in violation of the NYSE's own rules. Every time I hear Levitt on Bloomberg Radio I wince.

But the bubble of 1999 wasn't accompanied by excess leverage...as was the bubble of 2008.

At least Shiller wants to take money from billionaires so they don't become multi-billionaires. Obama wants to take money from from the middle class wage earners. That's a big difference even though it doesn't make either right.The rest of Shiller's comments are interesting but not of much use to the regular investor. I was surprised he went out on a limb and endorsed Buffet's value investing approach.

I am 78, a Yale graduate, class of 58; Yale Med School, 61.The dates are correct.Tuition on admission was $ 500. a year. Today it is listed as being in the $ 62,000 range.Ask Dr Schiller a simple question: Would America be better off today if Yale tuition were $25,000. a year or $100,000 a year.?In other words is, the cost of Yale college tuition experiencing irrational exuberance.?Charles R, Sachatello MD FACS

I think Mr. Shiller's interesting Q+A demonstrates that Economics is not pure Science, and that human beings shape markets and our shared Reality. He draws on the Classics to make predictions about the future, and clearly he is intellectual and has built on a classic Education. He's a futurist with a gloriously 'messy' desk, which probably makes perfect sense to him; he has a Blackboard that is not a Smartboard, yet he is very intelligent. He sits in a beautiful office in front of a fireplace, if indeed this space is his -- it shows that Classic Education can build the future if we don't forget that "Thinking" is a transferable skill, and Computers are Tools for Minds, not the other way around. Clearly, that paradigm has worked for him. I do worry that the fashionable statement about inequality refers to wealth re-distribution; in a Growth Economic model, wealth is distributed according to one's skill, and the market's need for Talent. There should be no 'you are too successful, and we will tax you for it,' mind set, for that discourages success, in my opinion. You don't raise the bottom by flattening the top, for often those at the bottom don't have the skills to generate capital or innovation. That problem will take one hundred years to solve, but without capital, you can't solve any of these problems. Most people who have a lot of money pay a lot of taxes; they pay workers; they pay for products; they contribute to charities. Nobody at the bottom can do that, so perhaps that should be considered; yet, all kinds of people can contribute to society in may different ways; it's important to remember that Technology is a TOOL, and that people have skill sets that can be developed; to me, that seems to be the best 'insurance' in a changing world. Interesting and thought provoking, thanks.

Does an economist really thing that someone eats 10 billion worth of food, depriving other people?

Of course they don't—they put the money to work creating wealth. When this person argues to take it away form the people who made the wealth it shows the naiveté of an academic pondering their navel. Excess money in the hands of wealth creators is used to create more wealth, when its stolen (because that's what confiscation is) the money is wasted.

"Inequality arguments" are nothing more than an excuse to steal from the productive to give to the politicians for their croneyism.

Dr. Schiller is just another example of the joke the Nobel prize has become. His reccomendtion to take from the wealthy is right out of the liberal progressive's "play book". It is college professors like him that are feeding BS to the young impressionable students.

The man is a fool, Nobel prize notwithstanding. Envy towards successful people, and no solutions towards rebuilding the middle class. All these Marxists decry "income inequality" but have no solution beyond confiscation. Maybe he doesn't understand fractional reserve banking. Free enterprise and strong protection of property rights always leads to wealth creation. We don't suffer from an unequal distribution of wealth, rather from an unequal distribution of free enterprise. I wonder how he feels about the wealth creation action by the Connecticut legislation which increased the minimum wage to $10.10. Or the stupid people of New Jersey who recently added minimum wage to the state Constitution. Proud of his prowess in residential real estate and too many years in the faculty lounge have lead to solipsism: refusal to acknowledge the common sense experience of the world as valid.

Inflation-adjusted asset price histories show bubbles best, look here:http://www.showrealhist.com/yTRIAL.htmlObviously, they are VERY instructive, but they are nearly never shown to people, which omission is intellectual savagery."The public's right to know" evolved to "Fool them if you can".

Shiller's comments about psychology and narrative are really interesting to me. I'd love to hear more about his concepts of personal-to-group psychological dynamics. Economists, like priests, can have remarkable insights into human behavior.

Loved your comment. It prompted me to recall that as a Junior at the UMI LS&A I was required to select a Major (1948). I didn't care much, just needed an AB in something to get in Law School. I selected Psychology. After just two classes I decided that was nonsense. Switched to Economics. Worse, but they would not let me switch. Did the job and Law School was great. After a long, satisfying and very rewarding career ai have seen nothing to conflict with my quick judgement re the fields of study.

Warren Buffett has never been awarded a Nobel Prize in economics but demonstrates year after year that he knows more than these guys with PhD's and trophies. He started from $0 to become one of the richest man in the world. A bank account speaks louder than a Nobel Prize.

I wouldn't say anything except for the fact that a lot of the Nobel prize winning "economists" (who are on the Wall Street payroll) are continually goading the middle class to "BUY STOCKS NOW" knowing full well that stocks are grossly overpriced and overdue for a correction.

Prof. Shiller's advocating stealing even more from the rich is pretty shameful. For one thing, it is the rich who save and invest. Working for a rich man is usually pays much better than working for a poor man. And what are we going to with the money we have stolen from a rich man ... spend even more for sex, booze, and rock and roll? I guess Prof. Shiller doesn't care much for Commandment #10.

I'll bet Prof Shiller doesn't give away much of his gigantic salary as a tenured professor of finance!

An interesting discussion, but giving governments more unearned money and power is not the answer to societal problems. Governments create havoc with unlimited resources and are prone to create more harm than good. There should be taxes but you should focus your economy and society more on eleemosynary work than forced distribution.

I have a hard time with any economist who thinks that there's a finite amount of money and that the only way to decrease the wealth gap is to take from one group to give to another. It seems a little at odds with a guy who, a few paragraphs earlier, admits to buying a 2nd house on an island for "fun". I wonder how he'd feel if the government seized 2nd homes bought just for "fun" to hand-over to the less fortunate.

Some great points on behavioural economics. Excellent pointers on what drives people to 'invest', such as stories that cause emotional turmoil. Also that most think their thoughts are original whereas most of it is fed via different channels. In fact it is estimated that more than 98% of our thoughts are based on borrowed information.

Interesting to see his take on tackling inequality. As he said it is very political. I see some here already posted comment proving Prof. Shiller's point.

And yet, I bet Warren Buffet and Shiller are of similar mind on how to solve income inequality in America. Its funny how people decide to simply ignore this man's many accomplishments because he uttered something they don't want to hear. He could be right, and you could be wrong.

Its a simple fact that a million dollars in the hands of a million people generates more economic activity than sitting in the bank vault of a single person.

And Warren B. also says taxes should be increased for the wealthy. I suspect WB would agree with Shiller as WB is also preparing to donate massive amounts of his wealth on when his personal bond is 'called.'

But it's the working poor man who protects and constitutes the government system allowing the wealth creation of the rich. So the rich have more vested in its existence; therefore, they should pay more to protect it.

Further hypocrisy-- professor Shiller enjoys guaranteed employment at a high salary from an institution that is hoarding $20 billion dollars (tax free) in its endowment while collecting taxpayer funds to subsidize the $42,000 per year tuition it charges. Time to start redistributing some of that endowment to the colleges that have none, I would think.

Mr. Warren, you state " it's unproductive for the economy for wealth to be further concentrated.". There's absolutely no proof that this is a valid idea. None. Whether I have a net worth of $10 or $10 billion there's only three things I can do with the money:

1) Spend it. In so doing, consuming, I pay others for their production....they gain in wealth.2) Put it in a bank. The bank has more deposits and makes more loans at cheaper rates....benefiting society. 3) Invest in productive entities. What matters, ultimately, to society is whether or not the capital investments being deployed (by whomever, corporate, individual or "government") are relatively productive. If I'm a stupid billionaire and invest poorly, society suffers and I'm not likely long to be a billionaire for long, am I? If I invest successfully, society is better off because I've supported "better", more productive, endeavors. The same holds true for corporations as well as government but only ONE of these actors has virtually no incentive to choose as wisely as possible. Government, right? It doesn't matter who makes the investments so long as those investments are continually "better" than alternatives.

Government motivations are virtually always a product of political motivations, FIRST. Consequently, the productivity of government "investment" is always worse than corporate or individual investment. Proof? Look at the vast sums wasted in public education. The priority isn't educating children, is it? Its reinforcing the public educational union, first. Want to make these monies maximally effective? Give parents vouchers and let them make choices........educational outcomes will improve very, very, rapidly when the power of the purse resides in those who have the most to gain by a given decision and that will never be the case with any massive, mindless, government.

Shiller is a fool. He states, conclusively, " If billionaires turn into multi-billionaires, we don't let that happen". Okay, what moral or constitutional authority gives government or society that right? To limit anyone? And if such a "right" exists (or Shiller's suggestion gains social currency) what in the world stops government from capping Shiller at.......one tenth his current net worth (not just his "fun" 2nd home)? Nothing, correct? Once "society" decides it has the "right" to take from an individual simply because that person has "too much" the line can be redrawn....and redrawn....and redrawn until everyone who produces anything only gets what "government" allows them. That's foolish and pretty incomprehensibly stupid for an economics professor to believe, morally or economically.

Paul -- if he says nothing original or even remotely insightful and a menace to wealth creation; yet, he a Nobel Prize winner and interviewed for the WSJ, he must be a really powerful man or you are missing something.

Your posts up to now have been tolerable, but placing yourself on a pedestal above others shows that you really don't bring much to the discussion yourself. When you get right down to it, the government really didn't build that, no matter what Barry says.

There is no constitutional authority to do so. But the Constitution is not a perfect and infallible construct. It is a man made, so stop invoking it as some universal and immutable principle. As for some sort of "moral"authority ? There's plenty of that. When you start refusing cancer patients treatment because your health insurance company stock could suffer, well, guess what ? You WILL be restricted and brought in line with civilized folk. The same applies to marketing tobacco products to minors or resisting testing for salmonella in food stocks or dumping billions of barrels of oil in some water body. Your profits and "freedom" become secondary to other matters.

The economic prize selection committee is composed entirely of college professors, and I believe they are all from Sweden. You really don't have to know or do something to win the prize, you just have to write papers that appeal to the committee's beliefs.

So, it's not much different than the Peace Prize they gave to Barry after all, is it?

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